Fund managers fall into similar traps of overconfidence
about their ability to manage the complex system of investing. Dr. Gawande
discusses investing (Chapter 8) by analyzing three public equity managers that
employee an explicit checklist and a study by Geoff Smart, which analyzed 51 venture
capital managers. The evidence, although not a large sample size, is compelling.
The public managers attribute the checklist to being a primary component of
their success and a distinct competitive advantage.

“The checklist doesn’t tell the
manager what to do. It is not a formula. But the checklist helps him be as
smart as possible every step of the way, ensuring that he’s got the critical
information he needs when he needs it, that he’s systematic about decision
making, that he’s talked to everyone he should. With a good checklist in hand,
he was convinced he and his partners could make decisions as well as human
beings are able. And as a result, he was also convinced they could reliably
beat the market.” “They (Checklists) improve their outcomes with no increase in
skill. That’s what we are doing when we use the checklist.” “When he first
introduced the checklist, he assumed it would slow his team down, increasing
the time and work required for their investment decisions. He was prepared to
pay that price. The benefits of making fewer mistakes seemed obvious. And in
fact, using the checklist did increase the up-front work time. But to his
surprise, he found they were able to evaluate many more investments in far less
time overall.” 1

And even though their competitors have noticed their success
and asked them for their secret, when told that the key is a checklist, they
turn up their nose.

“In the money business, everyone
looks for an edge. If someone is doing well, people pounce like starved hyenas
to find out how. Almost every idea for making even slightly more money— investing
in Internet companies, buying tranches of sliced-up mortgages, whatever— gets
sucked up by the giant maw almost instantly. Every idea, that is, except one: checklists.
I asked one of the equity managers how much interest others have had in what he
has been doing these past two years. Zero, he said— or actually that’s not
quite true. People have been intensely interested in what he’s been buying and
how, but the minute the word checklist comes out of his mouth, they disappear.
Even in his own firm, he’s found it a hard sell.” “I find it amazing other
investors have not even bothered to try,” he said. “Some have asked. None have
done it.” 1

The evidence from the VC community is even more compelling
because the results are more statistically significant (51 managers) and are
empirical. Mr. Gross categorized managers into five different categories by how
they made decisions. One of the classifications was “Airline Captains” which meant
they used checklists extensively to make decision.

“Smart next tracked the venture
capitalists’ success over time. There was no question which style was most
effective— and by now you should be able to guess which one. It was the Airline
Captain, hands down. Those taking the checklist-driven approach had a 10
percent likelihood of later having to fire senior management for incompetence
or concluding that their original evaluation was inaccurate. The others had at
least a 50 percent likelihood. The results showed up in their bottom lines,
too. The Airline Captains had a median 80 percent return on the investments
studied, the others 35 percent or less.” 1

Smart’s study was performed over ten years ago and his
findings are known by the VC community. You would think these fact-based
results would change behavior, but as Gawande found when asking about Smart
about behavior changes for VC managers:

“But when I asked him (Geoff Smart),
now that the knowledge is out, whether the proportion of major investors taking
the more orderly, checklist-driven approach has increased substantially, he
could only report, “No. It’s the same.” We don’t like checklists. They can be
painstaking. They’re not much fun. But I don’t think the issue here is mere
laziness. There’s something deeper, more visceral going on when people walk
away not only from saving lives but from making money. It somehow feels beneath
us to use a checklist, an embarrassment. It runs counter to deeply held beliefs
about how the truly great among us— those we aspire to be— handle situations of
high stakes and complexity. The truly great are daring. They improvise. They do
not have protocols and checklists.” 1

The Checklist Manifesto is well
worth the day or so it takes to read. The real question, are you willing to
adopt a Checklist mentality? Will you take the time to check the boxes? Are you
disciplined enough to stop yourself from making decisions unless those boxes
have been checked? I know that if I were back on the buyside, I would take out
my mini-checklist and expand on it, formalize, and refine as we improve our
process. I’ve seen firsthand the importance of making decisions explicit. But I
think Dr. Gawande says it best:

“Instead they (pilots) chose to
accept their fallibilities. They recognized the simplicity and power of using a
checklist. And so can we. Indeed, against the complexity of the world, we must.
There is no other choice. When we look closely, we recognize the same balls
being dropped over and over, even by those of great ability and determination.
We know the patterns. We see the costs. It’s time to try something else. TRY A CHECKLIST.” 1

1Gawande, Atul (2009-12-15). The Checklist Manifesto: How to Get Things Right. Picador.